Federal Student Loan Consolidation
The rising costs of higher education are prompting students to go further and further into debt in order to afford college. A Fidelity study estimates that the graduating class of 2013, for example, faces an average of $35,200 in college-related debt upon graduation. This includes federal and private student loans as well as credit card debt and money borrowed from family members. Federal student loans are generally the most attractive loan options due to their low and fixed interest rates and flexible repayment plans.
Many students will get federal loans for each year in school and will graduate with more than one loan to repay. If you have more than one federal student loan, you may be eligible to consolidate these loans into one Direct Consolidation Loan so that you are only making one payment a month instead of several.
Direct Consolidation Loan
Backed by the U.S. Department of Education, a Direct Consolidation Loan can help you streamline your federal loan payments. You cannot, however, consolidate your private student loans into a Direct Consolidation Loan. You may be able to consolidate private loans through a private financial institution, but this is not generally recommended. A federal Direct Consolidation Loan has a fixed interest rate based on the average interest of your federal loans rounded up to the nearest one-eighth of 1 percent. Repayment generally starts within 60 days of the disbursement of your loan, and the repayment term can range from 10 to 30 years, depending on the repayment plan you select, your additional educational loan debt, and the amount of your consolidation loan.
Loan Consolidation Requirements
In order to consolidate your federal loans, you must be either in your grace period or repayment period. Your grace period is determined by your loan and is the time period between when you graduate, drop below half-time status, or leave school and the time your first payment is due. The following loans are eligible for a Direct Consolidation Loan:
- Direct Unsubsidized Loans
- Direct Subsidized Loans
- Direct PLUS Loans
- Federal Family Education Loan (FFEL) Program PLUS Loans
- Unsubsidized Federal Stafford Loans
- Subsidized Federal Stafford Loans
- Federal Perkins Loans
- Health Education Assistance Loans
- Federal Nursing Loans
- Supplemental Loans for Students (SLS)
- Certain existing consolidation loans
If you include an additional Direct Loan or FFEL Program loan in your consolidation, you may be able to consolidate an existing consolidation loan, as well. If your parent took out a PLUS Loan on your behalf, you cannot consolidate this loan under your name if you are a dependent student, however. The Direct Consolidation Loan application has more information on which loans are eligible.
If you are in default of a student loan, meaning you have failed to make your payments as determined by your loan terms, you have to meet certain criteria before you are eligible for consolidation. Generally, there are two ways to become eligible. If you first make satisfactory repayment arrangements with your current loan servicer, the company responsible for the administrative tasks and billing of your loan, you may be able to consolidate. Additionally, if you agree to repay your Direct Consolidation Loan under the Pay As You Earn Repayment Plan, Income-Based Repayment Plan, or Income-Contingent Repayment Plan, you may be able to consolidate your defaulted loan.
Loan Consolidation Application Process
There is no fee to apply for a Direct Consolidation Loan, and the application process is relatively easy. You can apply online at StudentLoans.gov or download the forms, print and fill them out, and mail the application through the U.S. mail. The online application process consists of five steps:
- Choose your loan and loan servicer.
- Select your repayment plan.
- Read the terms and conditions.
- Fill out borrower and reference information.
- Review and sign your application.
You will need to sign in with your FSA ID in order to electronically apply for a consolidation loan and complete your Promissory Note. A Promissory Note is the legal document that lists the terms and conditions of your loan as well as your rights and responsibilities as a borrower. You will sign this to affirm your intention to repay your federal loan. It is important to keep a copy of this for your future reference.
Your FSA ID serves as a digital signature and individual identifier that gives you access to your personal loan information through the U.S. Department of Education. If you do not already have a FSA ID, you can create one at the website with your Social Security number, name, and date of birth. You can also reestablish your FSA ID or password if you have forgotten either.
The U.S. Department of Education is your lender for a Direct Consolidation Loan; however, independent companies selected by them will actually service these loans. You choose which of the predetermined servicers you wish to use for your consolidation loan. This is your point of contact for anything regarding your consolidation loan and whom you will make your payments to. You should continue to make payments on your existing loans until you have received confirmation from your Direct Consolidation Loan servicer that your underlying loans have been paid off.
Direct Consolidation Loan Repayment Plans
There are three main options to choose from for repayment of a Direct Consolidation Loan. They are the Income-Based Repayment Plan, Pay As You Earn Repayment Plan, and Income-Contingent Repayment Plan. The Income-Based Repayment Plan and Pay As You Earn Repayment Plan are based on the difference between your adjusted gross income and 150 percent of the poverty line, depending on your state of residence and family size. As your income changes, so do your payments, and both are dependent on a partial financial hardship. The payments will be lower than that of the 10-year standard repayment plan, but will extend the life of your loan, and you will likely pay more in the long run.
The Income-Based Repayment Plans and Income-Contingent Repayment Plans have a 25-year timeframe after which, if you have made qualifying monthly payments, the existing loan amount will be forgiven, although you will be responsible for taxes on the forgiven amount. The Pay As You Earn Repayment Plan has a term of 20 years. In the Income-Contingent Repayment Plan, your monthly payments are based on your adjusted gross income, family size, and amount of your Direct Loans, and it will be calculated annually.
All three plans will generally have lower payments than those associated with the 10-year standard repayment plan but will extend the life of your loan, and you will likely pay more in the long run. Your loan servicer will have the specific information on which repayment plans they offer.
Pros and Cons of Consolidating
While the thought of making your life easier and simplifying your loans into a single more manageable monthly payment may seem appealing, it may actually backfire and cause you more headaches. Loan consolidation should be carefully thought out, and you should consider all your options first. You may actually end up paying more in the long run if you extend your repayment period to the full 30 years available, for example. Even though you may end up paying less each month with a consolidation loan, you will make more payments for a longer time, thus increasing the total amount in interest you will pay. On the plus side, if you had any variable interest loans, a Direct Consolidation Loan will give you the option fix the interest rate for the life of the loan and also may make you eligible for different repayment plans. Additionally, interest rates are based on an average of your loan’s interest rates for consolidation purposes, so if you have a low interest rate loan and a high interest rate loan and you consolidate them, you will end up paying more interest on your lower interest loan.
When you consolidate your loans, you will enter into a new legally binding contract, and the terms and conditions will likely be different from your original loan terms. Also, any benefits you may have received from the terms of your initial loan will now be nullified. If you have a Perkins Loan, you may be eligible for loan forgiveness – where you don’t have to pay the loan back – if you join the Peace Corps, enter law enforcement, are deployed with the military, or enter certain fields of education, for example. When you consolidate a Perkins Loan, you lose this option permanently. Parent PLUS Loans are also not eligible for many of the repayment plans, and by adding it to the Direct Consolidation Loan, you may cut off some of your flexible repayment options. By entering into a Direct Consolidation Loan, you will lose some borrower benefits that may include principal rebates, interest rate discounts, or loan cancellation benefits that may have been offered under some of your federal student loans.
Conversely, you will have access to other repayment options such as the Pay As You Earn Repayment Plan that you may not have had access to with your original loans. Be sure to consider all short-term and long-term effects of loan consolidation before making the choice.